From our point of view, an investor can only be successful if he has developed an investment style that is coherent with his personal interests and his psychological constitution.
We believe it does not work to mimic specific techniques or copy select investors. But, we can say – after deep study and much trial-and-error – that we feel closest to Warren Buffett and Charlie Munger.
Both published in 1983 so-called Owner-oriented Principles to explain to their investors, i.e. the stockholders of Berkshire Hathaway, what they can expect from an investment in Berkshire Hathaway. Following these and other role-models we have developed our own Investment Principles and see them as an effective means to explain our approach.
The following 10 points shall illustrate how we invest and why we invest that way:
- How do we see the financial markets and what does it mean to buy a stock?
Value Investing has become a buzzword. If you ask market participants what it actually means they often respond: it is an investment strategy where you buy a company at a discount to the accounting value of its assets. This may indeed happen from time to time. However, the thought process of a Value Investor is much more far-reaching than this simplistic formula implies. In our mind, the key ingredient of Value Investing is its specific point of view regarding financial markets. Large parts of the finance community have built a rather complex theory based on the ‘Homo Oeconomicus’, whose rational acts lead to efficient capital markets. To counter this theory Benjamin Graham (Buffett‘s Mentor) invented the image of Mr. Market. Mr. Market is not rational all the time – in fact, he is a rather emotional fellow. At times he is manic-depressive. And then again he becomes overwhelmingly optimistic. These extreme states of mind are then also reflected in the price he proposes to pay for a certain security. Now, if an investor knows the truth, the so-called intrinsic value of a company, he will be able to generate attractive returns by doing business with Mr. Market. He buys securities when Mr. Market is manic-depressive and sells them when Mr. Market is overly optimistic. In essence: Value Investors believe that assets can be mispriced. The mispricing can be exploited systematically and hence represents a considerable opportunity for patient and long-term investors. We fully adhere to this view of the capital markets and therefore see ourselves wholeheartedly as disciples of the Value Investing community. When looking for the intrinsic value of a company it is paramount to understand what it actually means to buy a stock. If we buy a stock, we become in fact co-owner of the company. We identify ourselves with the company’s products and its services. This aspect is of utmost importance to us. It is a demarcation to numerous trading strategies where the stock is metaphorically speaking a mere pixel on the Reuters or Bloomberg terminal.
- What do we think about market timing?
Consequently, success and failure of our investments will depend on whether we judge correctly the intrinsic value of a company. Economic analyses are of only limited importance for this endeavour. We will not directly try to bet on the ups and downs of the market. In fact, we do not believe that you have a reasonable chance to systematically predict the market movements.
Nevertheless, our bottom-up approach focused on individual companies will lead to an implicit market timing. If we identify attractive risk-return-opportunities with a high Margin of Safety (difference between current market price and intrinsic value), we will willingly increase our exposure and invest in these opportunities. If the market is overpriced, i.e. Mr. Market overly optimistic, then we will find only a smaller number of attractive investment opportunities. Our exposure should then be limited and therefore less risky. To use Warren Buffett‘s words: Be greedy when others are fearful. Be fearful when others are greedy. We try to adhere to his advice… every day.
- What do we think about volatility?
Capital markets see volatility as the key indicator of risk. But actually it only shows how uncertain market participants are about the future of a company. For us, volatility is not the adequate indicator to assess the risk of our investments. Let’s assume a company has an intrinsic value of 100 and its market price falls to 70. Is it more or less risky to buy the company at the reduced price?
We see the short term ups and downs of the market, especially the downs, not as a risk but rather as an opportunity. For us, the only relevant risk is a deterioration of the intrinsic value of the company.
- What are we looking for in our investments?
Our principal duty is to identify a) the intrinsic value of a company or more generally speaking of an asset and b) a discrepancy of this value compared to the current market price. As a general approach, we will develop different future state scenarios for the company and assign probabilities / likelihoods. We will then aggregate this into an expected value for the company. The difference of the current market price to our expected value is our Margin of Safety. The market should correct the mispricing in the long run and therefore generate a handsome return for us as investors. The Margin of Safety should also protect us from unforeseen negative evolutions or any mistakes in our initial assessment.
We will pay special attention to situations where the market price reflects all negative scenarios for the company but neglects potential positive evolutions. If we identify these situations, we might well invest a significant share of our portfolio. These investments have a strong upside potential with limited downside risk.
- Do we have specific investment criteria?
Traditionally, Value Investors have a long check-list to identify companies with extraordinary potential. These check-lists ask for a remarkable competitive positioning (moat), a strong company culture, and impeccable management etc.
We also analyse companies along those criteria and they are very important to us. But, it is not systematically a show-stopper, if the one or the other criteria is not checked. The check-list is merely one input parameter in our assessment of the company’s intrinsic value.
- Do we have a diversified investment strategy?
As mentioned, finance theory considers capital markets to be efficient. Under this assumption, investors should aim for a very broad diversification, i.e. invest in many different companies or assets.
We believe that companies can – at least temporarily – be mispriced. We therefore prefer to invest in a very focused way, i.e. in a small number of companies… our best ideas. We will monitor these companies very closely and continuously challenge our investment case. We will typically invest in 10-20 companies at a time and we do not actively seek a diversification across sectors. This has two main reasons: Firstly, we would not be able to cover more companies as closely as we want. Secondly, we do not want to invest our limited resources in our 21st best idea. We want to invest heavily in our best idea.
We have one objective: long-term wealth creation. Investors with a short- to mid-term horizon or a wealth protection mindset would certainly apply a different investment strategy.
- What do we think about marketing?
Such a focused Investment strategy based on mispricings can be disturbed or even threatened by erratic in- and outflows. We therefore only want to work with long-term oriented investors that have an entrepreneurial mindset and adhere to our investment philosophy. The quality of assets under management is important, not the quantity. This has a tremendous impact on marketing considerations: The manager and the investor need to become true partners with strong bonds and mutual understanding. A true partnership requires first of all that you know each other personally.
From the investors, it requires a long-term commitment.
From the manager, it requires full transparency!
The manager has to explain his investment strategy and approach to his investors, both using regular ‘letters to the investors’ and through personal meetings.
- What is our setup?
Our main focus is on researching companies. We seek an environment that keeps us as objective as possible and protects us from the ‚noise‘ of the capital markets. We do not constantly have one eye on the stock prices. We do not have a Reuters or Bloomberg terminal – on purpose! Ok, we do not sit in Omaha but we are still outside the tumultuous world of the big financial centers.
It is important to us to fully understand our companies. We meet them regularly, we get to know employees, we talk to clients, and visit relevant trade fairs.
We are privileged: we are part of a strong network of like-minded investors around the ‘Investmentaktiengesellschaft für langfristige Investoren’ (Bonn, Germany).
- How do we measure success?
Unfortunately, no one knows the ‚true‘ intrinsic value of a company nor its ‚true‘ risk-return profile. You only see at the end of the investment whether you made money or not. But even this does not prove whether you made a good decision from an ex-ante perspective.
A simple example may illustrate the issue and our approach to it: Let’s flip a coin. You win 1 EUR for ‘head’, 0 EUR for ‘tails’. Here, the intrinsic value is quite obvious, i.e. 0.5 EUR as there are only two possible outcomes with a known probability distribution. If we could find such a risk-return profile on the market at a price of 0.1 EUR, we would have done – in our opinion – a great job. This would obviously be an attractive investment opportunity, i.e. a good ‚buy‘ (after all we pay 0.1 EUR for something that is worth 0.5 EUR). But still, it is possible that you get three times in a row ‚tails‘, i.e. ex-post it would have been a bad investment.
On top of the above, you also have to consider that there will be a performance impact on how we position ourselves during different market cycles (Hausse & Baisse). If we do not find attractive investment opportunities because the market is overpriced, then we will not invest just to be invested. That means: if the market is overpriced, we will willingly accept a temporary underperformance in case the market continues to rally.
All in all, not an easy environment to measure our performance.
Here is our pragmatic point of view: If we identify over and over again attractive ex-ante opportunities, then we should in the long run – according to the law of large numbers – generate an overperformance.
In the long term, we measure ourselves against the opportunity costs of our capital. Our capital would do well (without us), if it was invested in one of the main European stock indexes, such as the German DAX or the French CAC40. Our objective is to do better – not necessarily in the short but certainly in the long run.
- How do we invest our money?
A true partnership requires interests to be aligned. That is why we as sub-advisor to the TGV Rubicon Stockpicker Fund invest right from the start a substantial amount of our private wealth alongside the other investors. Our objective is long-term wealth creation for the investors and ourselves via our activity as sub-advisor. To once again use Buffett’s words: “we eat our own cooking”!